Real estate syndications are structured so that the sponsor is motivated to ensure the investment performs well for everyone. There is a distinct advantage to investing passively, rental income and property appreciation. Payment depends upon the time the investment needs to mature. Could be months or years. Everyone who invest, receive some share of the profits. Passive investing is where investors enjoy high returns without being exposed to personal liability or credit risk.
Passive investments mean you are pooling your money with other investors to purchase multifamily properties. One of the biggest benefits to the real estate business model is the ability to buy on borrowed money. Passive investments offer access to deal flow and the change to invest in high quality real estate. Perhaps the most significant benefit of syndication is the ability to become a passive investor.
The investors’ role in real estate syndication is quite simple since they invest their money in the project that the syndicator runs and manages. Then, they earn a percentage of the profits based on a prearranged structure.
Every syndication has two types of investors. General partner/Syndicator/Sponsor and Equity partners/Limited partners.
Syndicator leads the transaction. The Syndicator invest the sweat equity, including scouting the property, raising funds and acquiring and managing the property operations. Syndicator creates large investment opportunities and allows you the opportunity of pooling funds with other investors which will gain you access to larger investment opportunities. They do everything, from searching for the right deal, negotiating, performing due diligence and managing the properties. Meaning the syndicator/sponsor takes care of all the details and handles all these aspects.
Equity partners/Limited partners are passive investors who invest their money with the syndicator/sponsor. They are a group of people that will provide the private equity funds for the deal. They invest their money in a project that the syndicator runs or manages. Then, they earn a percentage of the profits based on a prearranged structure.
Passive investing is one of the best ways to receive the benefits of owning a large apartment building without the time commitment, funding the entire project or obtaining the expertise require to create and execute a business plan.
A passive investor might not see the same returns as an active investor who is finding, qualifying and closing on an apartment building use their own capital and overseeing the business plan through its successful completion. But compared to other passive investment vehicles, like stocks, bonds or REITs, apartment syndications cannot be beat (assuming the passive investor has found the right general partnership and qualified their team).
The returns offered to the limited partner (i.e. the passive investors) vary from general partner to general partner. Before making the commitment to invest, the limited partners (referred to as the LP hereafter) should understand the general partner’s (referred to as the GP hereafter) partnership structure, which includes the type of investment structure and how the returns are distributed.
Typically, a passive investor is either an equity investor or a debt investor in an apartment syndication.
Equity Investor are passive investors who invest their money with the syndicator/sponsor
Of the two main types of investment structures, being an equity investor is the most profitable, because they participate in the upside of the deal. However, they typically will not receive their initial equity investment until the sale of the apartment.
The equity investor is offered an ongoing return, as well as a portion of the profits at sale. Generally, after the operating expenses and debt service are paid, the portion of the remaining cash flow is distributed to the LP. For some partnership structures, the GP will take an asset management fee before distributing returns to the LPs. I do not like this approach since it decreases the alignment of interest because the GP receives payment before the LP. So, my company puts our asset management fee in second position to the LP returns (which means we don’t get an asset management fee until we’ve paid the LP).
The most common ongoing return is called a preferred return. The preferred return ranges from 2% to 12% annually based on the experience of the GP and their team, the risk factors of the project and the investment strategy. The less experience and the more risk, the higher the returns. In regards to the preferred returns associated with the three main apartment syndication investment strategies, the GP will offer the highest percentage for distressed apartments and the lowest percentage for turnkey apartments, with value-add apartments falling somewhere in-between.
The equity investor also participates in the upside of the deal, which means they are offered a portion of the sales proceeds.